The concept of trading on the Forex market is based on the process of buying one currency for another and inverse an operation of selling it, to make profit. You can make such transactions with almost every currency of the world. Let us analyze some examples.
Example 1: You have 1600 USD and the exchange rate of GBPUSD is 1.6000, which means that you can buy 1000 GBP for 1600 USD. You buy 1000 GBP, hoping that GBP will rise against USD. After a while, GBP really rises against USD up to 1.6100 for 1 GBP. At such rate, you can exchange 1000 GBP for 1610 USD. This way, you have fixed a profit of 10 USD.
Example 2: Let us assume that you have 1000 GPB, and the exchange rate of GBPUSD is 1.6000. You sell your GBP for 1600 USD and you hope that GBP falls against USD. After a while, the rate falls up to 1.5900, and you decide to make a reverse operation and buy GBP for 1600 USD at this rate. As a result, you have 1006.28 GBP. This way, you have fixed a profit of 6.28 GBP.
- You can earn with both ways: when one currency either rises or falls against another one.
- The currency always rises or falls only against another one.
Currency Pairs, Cross Currency Pairs and Their Quotations
The main instrument on Forex is a currency pair – a ratio of one currency to another. There are more than 100 currency pairs on the market. Some currency pairs are traded in bigger volumes, whereas some of them – in smaller volumes. For example, 66% of all volume traded comes to major currency pairs (majors).
These pairs are EURUSD, GBPUSD, USDJPY, USDCHF, AUDUSD and USDCAD. You have noticed that each pair contains USD. It is because USD is a world reserve currency. USD participates in absolutely all currency transactions.
Those currency pairs that do not contain USD, are called cross currency pairs. The calculation of the rates of these currency pairs is carried out with the help of USD. For example, the calculation on the currency pair EURJPY will be executed this way: EURUSD to USDJPY.
When you take a look at the table of quotations on FOREX, you will see two rates in front of every currency pair. Rate to buy and rate to sell.
Currency, that stands first is called base currency. Absolutely all operations are carried out with the base currency. For example, EURUSD. You sell or buy EUR for the USD that you have in your account. In case you have another currency in your account, for instance, you have a GBP account, to complete the transaction on EURUSD, an automatic operation of pound-dollar conversion occurs, and the trader does not bear any costs and does not make any unnecessary actions. Everything is done automatically.
Currency, that is second in the currency pair is called quoted currency. It is the expression of base currency price. If EURUSD = 1.4000, this means that 1 EUR can be bought for 1.4 USD. Currency, that stands second, shows the result of the ratio of two currencies to each other. This ratio is called quotation.
In the classic version, the quotation has a fourth decimal pricing format.* The minimal quotation change falls on the last digit and is called point or pip. For example, EURUSD changes from 1.4000 to 1.4001. This means that the rate of this currency rises by one pip. However, the fourth decimal pricing format is the feature of classic accounts only. NDD and ECN accounts have fifth decimal pricing format.* This allows you to monitor the changes of the quotations by fractional pips.
* In currency pairs with JPY, quotations are displayed in 2d decimal pricing (3d for NDD and ECN). For the USDJPY currency pair, the quotation will look like this: 84.85. If the rate rises to 84.86, this means that it rises by one point.
Bid and Ask
When you take a look at the table of quotations on Forex, you will see two rates in front of every currency pair: rate to buy and rate to sell. The price to buy is always higher than the price to sell. Sell rate is called Bid, and buy rate is called Ask. Buy orders are opened at Ask price and are closed at Bid price. Sell orders are opened at Bid price and are closed at Ask price. The difference between Bid and Ask is called spread. Spread is determined in points.
Leverage and Margin on Forex
There are two very important terms on the Forex market: margin and leverage. Forex trading usually occurs with sufficiently large volumes of money (one standard lot is 100 000 units of base currency). There is always an opportunity to trade smaller volumes (e.g., 0.01 lot or 1000 units of currency), but not everyone, who wants to try Forex trading has such a sum of money. That is why traders get a chance to use leverage.
Leverage lets one trade bigger sums, having much smaller sums on the trading account. JustForex offers different sizes of leverages: 1:1 up to 1:3000. For example, you decide to use 1:100 leverage. Therefore, to trade one standard lot, you need to have 1000 units of currency. In this case, 1000 units of currency will be your margin.
To learn all the terms that the trader should know while working on the foreign exchange market, please visit the page Definitions.